How to Perform Accounting for Payroll Taxes

Accounting for payroll taxes is the systematic recording of all financial transactions related to employee compensation and the associated tax obligations. This process ensures that a company’s financial statements accurately reflect its labor costs and that it remains compliant with various tax regulations.

Identifying Payroll Tax Components

Payroll accounting begins with identifying the specific taxes involved, which fall into two main categories. The first category consists of taxes withheld from an employee’s paycheck, which the employer collects for the government. These include federal and state income tax, with the amounts determined by an employee’s Form W-4, as well as the employee’s share of FICA taxes.

FICA taxes, from the Federal Insurance Contributions Act, fund Social Security and Medicare. For 2025, the Social Security tax is 6.2% on wages up to $176,100, and the Medicare tax is 1.45% on all wages. An additional 0.9% Medicare tax applies to employee earnings over $200,000.

The second category of taxes is the employer’s direct responsibility, which includes a matching share of FICA taxes. This means employers also contribute 6.2% for Social Security and 1.45% for Medicare for each employee. Employers are also responsible for federal and state unemployment taxes.

The Federal Unemployment Tax Act (FUTA) tax is 6.0% on the first $7,000 of each employee’s annual wages. Employers who pay their state unemployment taxes on time can receive a credit of up to 5.4%, reducing the effective FUTA rate to 0.6%. State Unemployment Tax Acts (SUTA) also require employer contributions, and these rates vary by state.

Setting Up the Chart of Accounts for Payroll

Before recording payroll transactions, a company must establish a structured chart of accounts. This list of all financial accounts in the general ledger requires specific expense and liability accounts to properly categorize payroll transactions.

On the expense side, two accounts are needed. The Wages Expense account records the gross earnings of all employees before any deductions. A separate Payroll Tax Expense account records the employer’s share of taxes, such as their portion of FICA and all FUTA and SUTA taxes.

For liabilities, several “payable” accounts are needed to track funds that are owed but not yet paid. A Wages Payable account holds the net pay due to employees after deductions. Separate liability accounts should be created for each type of tax withheld and owed, including:

• Federal Income Tax Payable
• FICA Taxes Payable
• FUTA Tax Payable
• SUTA Tax Payable

Using distinct accounts for each tax liability simplifies the process of remittance and reconciliation.

Journal Entries for Recording Payroll

Recording payroll begins with a journal entry that captures all financial elements of a pay period. This entry is made when payroll is processed, not when employees are paid, to recognize the expenses and corresponding liabilities. The entry includes debits to expense accounts and credits to various liability accounts.

To illustrate, for an employee with a gross pay of $2,000, the journal entry starts with a debit to Wages Expense for the full $2,000. Next, liabilities withheld from the employee’s pay are recorded as credits. For example, if $200 is withheld for federal income tax, a credit of $200 is made to Federal Income Tax Payable, and the employee’s $153 share of FICA taxes (7.65%) is credited to FICA Taxes Payable.

The employer’s tax obligations are also recorded. The employer’s matching FICA contribution of $153 is debited to Payroll Tax Expense and credited to FICA Taxes Payable. Any FUTA and SUTA taxes owed would also be debited to Payroll Tax Expense and credited to their payable accounts. The remaining amount, the employee’s net pay of $1,647, is credited to Wages Payable.

Journal Entries for Paying Payroll Taxes

After payroll liabilities are recorded, the next step is to pay the collected and owed taxes to government agencies. This action is recorded with a second journal entry that clears the liabilities from the company’s books. This entry reduces both the company’s cash and its recorded tax obligations.

The journal entry to pay payroll taxes involves debiting the liability accounts that were credited in the initial payroll entry. For instance, paying the federal income taxes withheld requires a debit to the Federal Income Tax Payable account. The same process applies to FICA, FUTA, and SUTA taxes, with debits to their respective payable accounts.

The other side of this entry is a credit to the Cash account for the total amount paid. This entry reflects the cash outflow and reduces the payroll tax liability account balances to zero.

Reconciling Payroll Accounts to Tax Forms

The final step is to reconcile the payroll accounts in the general ledger with the tax forms filed with the government. This process verifies that the amounts recorded match the amounts reported to tax agencies, ensuring accuracy and compliance. The primary forms used are the quarterly Form 941, Employer’s Quarterly Federal Tax Return, and the annual Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return.

To perform a quarterly reconciliation, a business should compare the totals from its payroll register for the quarter with the corresponding lines on Form 941. For example, the total federal income tax withheld, as shown in the Federal Income Tax Payable account, should match the amount reported on the form. Likewise, the total Social Security and Medicare wages and taxes in the FICA Taxes Payable account should align with the figures on Form 941.

Any discrepancies discovered during this reconciliation must be investigated and corrected promptly, which might involve adjusting payroll records or filing an amended tax return. At the end of the year, the totals from the four quarterly 941 forms should be reconciled with the annual totals on Form W-3, the Transmittal of Wage and Tax Statements. This ensures consistency across all federal filings.